Adobe 3QFY2025 Earnings Review: Overshadowed by Leadership Transition and AI Monetisation

Key Points

• Despite a strong quarter, the company once again failed to convince investors that it can fully capitalise on AI tools rather than be displaced by them, which we believe was the primary reason for the sell-off.
• As such, we maintain our BUY recommendation on Adobe, with a target price of US$320 by FY2028, representing an upside potential of approximately 63% from the current share price.
• Factors weighed: (1) CFO Dan Durn's departure on June 15 — the second senior leadership change after CEO Narayen's announced exit — raised concerns about execution continuity during a pivotal AI transformation; (2) the freemium strategy pivot signals willingness to sacrifice near-term ARR growth for user acquisition, which introduces forecast risk for the next several quarters
• The US$500 million milestone matters because it demonstrates that generative AI is converting freemium users into paying subscribers, providing evidence that Adobe is beginning to monetise AI adoption rather than solely absorbing disruption risk.

The Key Risk: Monetisation and Cannibalisation

During the latest earnings call, Adobe indicated that it intends to prioritise growing users of its AI features through its freemium model, allowing users to try its AI products without paywalls and delaying previously planned price increases.

Management stated that "acquiring new customers through a frictionless onboarding process without immediate paywalls will be the best way to drive adoption of Adobe's AI products".

This follows strong growth in Acrobat and Express monthly active users, as well as Creative Freemium monthly active users.

While this strategy may increase adoption, it also delays the point at which user growth translates into annual recurring revenue, potentially hampering short-term revenue growth. We therefore expect pressure to build in Adobe's second-half ARR performance.

At the same time, there is a technical and economic trade-off. Generative AI is not free to operate. Every prompt requires inference on computing infrastructure. If free usage expands faster than paid conversions, Adobe could face rising service costs without a corresponding increase in recurring revenue.

Therefore, despite a strong quarter, the company once again failed to convince investors that it can fully capitalise on AI tools rather than be displaced by them, which we believe was the primary reason for the sell-off.

Nevertheless, the fact that full-year revenue and earnings guidance exceeded expectations suggests that management does not expect the strategy shift to result in significant cannibalisation effects — a point that may not yet be fully reflected in investor sentiment.

Leadership Transition Risk – CFO departures

The freemium transition is unfolding while Adobe prepares for leadership changes.

Following CEO Shantanu Narayen's announcement last quarter that he plans to step down once a successor has been selected, CFO Dan Durn has now announced that he will leave Adobe on 15 June to join Marvell Technology, with the SVP of Corporate Finance serving as interim CFO.

These consecutive rounds of senior management reshuffling have increased investor concerns regarding execution continuity, as both top executives announced their departures at a time when the company is facing one of its biggest strategic challenges in more than a decade.

Leadership transitions do not invalidate Adobe's strategy, but they increase execution risk. The next management team will need to decide how aggressively to subsidise free AI usage, which features remain premium, and whether to prioritise near-term recurring revenue or a larger long-term user base.

Investment Debate Now Shifts To Execution

The fundamental print was strong across every line. The investment debate has now shifted entirely towards whether the freemium pivot and dual leadership transition will dampen near-term ARR momentum, and whether AI-first ARR can scale quickly enough to offset any resulting drag.

The market's concern is that Adobe's shares could decline further following the strategy shift, which effectively deprioritises near-term revenue growth, and that the availability of free AI tools could reduce Adobe's pricing power in the future.

Accordingly, we have lowered our FY2026 revenue growth forecast to 9%, followed by a 9% CAGR through FY2028 (previous forecast: 9.4% CAGR). We have also reduced our EPS forecasts, reflecting expected margin compression arising from changes in the pricing model and rising inference and cloud costs as Firefly video and audio consumption scales.

Overall, we acknowledge the headwinds that the company is facing (decelerating organic growth, shift in pricing model affecting earnings visibility and cost structure, concurrent CEO and CFO transitions), but our key thesis still stems from 1) still respectable headline growth, 2) the long-term monetisation potential of the freemium model 3) deep valuation discount against peers and historical average.

The stock continues to trade at a significant discount relative to peers and its historical valuation range, with a single-digit forward P/E multiple. We believe the market has over-penalised the stock, creating scope for a valuation re-rating should execution concerns moderate.

As such, we maintain our BUY recommendation on Adobe, with a target price of US$320 by FY2028, representing an upside potential of approximately 63% from the current share price.

Figure 1: Adobe trading at largest discount against software sector since a year ago

Table 4: Valuation Table